Sovereign Credit Risk, ESG Performance, and Idiosyncratic Volatility in a Turkish State-Owned Bank: A Regime-Switching Analysis

Abstract

Environmental, social, and governance (ESG) considerations and sovereign credit risk have reshaped how bank-level risk is understood in emerging markets. This paper examines the determinants of idiosyncratic volatility (IVOL) in Halkbank, the Turkish state-owned commercial bank with the highest public float. Using quarterly data from 2009Q1 to 2024Q3, we isolate IVOL from a Fama–French five-factor model constructed for Halkbank and estimate a two-regime Markov switching regression (MSR), with a dynamic ordinary least squares (DOLS) model as a robustness check. Sovereign credit default swap (CDS) spreads are positively associated with IVOL, and the association is larger in the high-volatility regime. ESG performance is negatively associated with IVOL, and this association is also stronger in the high-volatility regime. Wald tests confirm that both the CDS and ESG coefficients differ significantly across regimes, indicating that the relationships are state-dependent rather than constant. Bank-specific fundamentals and macroeconomic indicators are not statistically significant once sovereign risk and ESG are included. A Hansen parameter-instability test supports a long-run cointegrating relationship, and the DOLS estimates are consistent with the MSR results. The findings have implications for risk management, investment, and supervision in bank settings characterised by state ownership and strong sovereign-bank linkages.